Using novel data on European firms, this paper examines the effect of business group affiliation on innovation. We find that business groups foster the scale and novelty of corporate innovation. Group affiliation is particularly important in industries that rely more on external finance and have a higher degree of information asymmetry. We also find that the innovation of affiliates is less sensitive to operating cash flows. We interpret our results as supporting the âbright side' of business group internal capital markets and explain how legal boundaries between group affiliates mitigate the inefficiencies found in internal capital markets of US conglomerates. Keywords: business groups, innovation, internal capital markets JEL Classifications: G34, L22, L26, and O32
This paper was produced as part of the Centre's Productivity and Innovation Programme. The Centre for Economic Performance is financed by the Economic and Social Research Council. Acknowledgements
We express our special gratitude to Patrick Bolton, Francisco Perez-Gonzalez, Mark Schankerman and John Van Reenen for numerous helpful discussions. We are also grateful for valuable comments from Nick Bloom, Steve Bond, Bjorn Jorgensen, Tarun Khanna, Daniel Paravisini, Tano Santos, Catherine Thomas, Manuel Trajtenberg, Daniel Wolfenzon, Yishay Yafeh and seminar participants at Columbia University (GSB), Hebrew University, London Business School Transatlantic Conference, London School of Economics, NBER, and Oxford University. We thank Liat Oren for invaluable assistance with the programming of the ownership algorithm, Hadar Gafni for excellent research assistance, and the Institute for Fiscal Studies, especially Rachel Griffith and Gareth Macartney, for the EPO patent matching. All remaining errors are our own.
Sharon Belenzon is a Research Economist with the Productivity and Innovation Research Group at the Centre for Economic Performance, London School of Economics. He is also a Postdoctoral Research Fellow at Nuffield College, University of Oxford. Tomer Berkovitz is a Postdoctoral Research Fellow at Columbia University, Graduate School of Business, NY, USA. Published by
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London School of Economics and Political Science
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Â© S. Belenzon and T. Berkovitz, submitted 2007
Extensive empirical literature over the past three decades has investigated the incen- tives of firms to innovate and the effect of innovation on performance. 1
La Porta et al. (1999) showed that outside the US, legally independent firms are commonly tied together through ownership links to form business groups. Yet, little attention has been devoted to the relation between business groups and innovation. This is especially surprising in light of the long debate in the literature on the effect of firm boundaries on the allocation of resources (Coase (1937), Mullainathan and Scharfstein (2001)).
In this paper, we provide a new perspective on how the bound- aries between firms may affect the allocation of internal funds to R&D activity. Using a novel database, we show that while large organizations comprised of a single legal entity have been found to stifle innovation (e.g. Seru (2007) on US conglomerates), business groups foster innovation via a more efficient internal capital market. In a world with asymmetric information, Myers and Majluf (1984) and Greenwald et al. (1984) argue that external financing is more costly than internal...